Tier 1 capital

Tier 1 capital

The Tier 1 capital ratio is the ratio of a bank's core equity capital to its total assets. The Tier 1 risk based capital ratio is the ratio of a bank's core (equity capital) to its total risk-weighted assets. Risk-weighted assets are the total of all assets held by the bank which are weighted for credit risk according to a formula determined by the Regulator (usually the country'scentral bank). Most central banks follow the Bank for International Settlements (BIS) guidelines in setting formulae for asset risk weights. Assets like cash and coins usually have zero risk weight, while debentures might have a risk weight of 100%.

A good definition of Tier 1 capital is that it includes equity capital and disclosed reserves, where equity capital includes instruments that can't be redeemed at the option of the holder (meaning that the owner of the shares cannot decide on his own that he wants to withdraw the money he invested and so cannot leave the bank without the risk coverage). Reserves are held by the bank, and are thus money that no one but the bank can have an influence on.

For laypeople, Tier 1 capital is seen as a metric of a bank's ability to sustain future losses. It is the way to track how much risk any particular bank is taking on, in terms of dollars held per dollars loaned out. For example, a 10% Tier 1 capital ratio means a bank is holding in its vaults or likewise locations $1 for every $10 that a customer has in their account balance. Therefore, the other $9 is fiat money.

source: wikipedia